Statement of Comptroller Dugan on the Results of the Supervisory Capital Assessment Program

WASHINGTON — Comptroller of the Currency John C. Dugan issued the following statement today on the results of the Supervisory Capital Assessment Program (SCAP):

The results of the stress test demonstrate the strength of the banking system and its ability to withstand losses and sustain lending, even if economic conditions are more severe than currently anticipated. I want to emphasize several key points about the results of the test.

First, the stress test is not a solvency test. It is designed to be a significantly adverse, lower probability scenario; it is not a prediction that the scenario will occur or that the bank is undercapitalized or insolvent today.

Second, the purpose of the test is to create an excess capital buffer in case the adverse scenario comes to pass. Once the buffer is in place, if the adverse scenario occurs, the bank will still be more than adequately capitalized; if it does not, the bank will still be viewed as stronger today for having higher levels of capital in an uncertain world.

Third, the stress test criteria were appropriately conservative; this was a severe test, and high capital requirements were used to measure success. Conservative assumptions were made with respect to the three key elements of the test: loss rates, revenues, and loan loss reserves. For example, with respect to aggregate loan losses, the 9.1 percent two-year loss rate was higher than any two-year loss rate since 1921, including the worst two-year period of the Great Depression. Similarly, assumed losses on individual categories of loans were very high by historical measures. While our data set for these individual categories goes back only about 20 years, the annualized loss rates in the stress test were substantially higher than the highest annual losses during this period – and the stress test assumed these higher levels for two years, not one. Moreover, the test assumes that these very high rates of loss strike all categories of loans simultaneously, which has not been observed historically – losses generally don’t peak for all types of loans at the same time.

Fourth, banks generally had enough overall Tier 1 capital to survive the severe stress – a very positive sign for the overall strength of the banking system. The results show that, with the capital already provided by the U.S. government to these banks last year through the Capital Purchase Program, the 19 banks generally have enough overall Tier 1 capital to withstand an unlikely but very adverse stress period. That is a very positive result.

Fifth, the test shows that many banks do not have enough Tier 1 common equity for such a stress period, and the key consequence of the test is the need to increase such equity. Supervisors have been concerned about improving the quality of capital to absorb losses, and the test results confirm this concern, showing that some banks need to increase common equity. Doing so should also help address concerns we’ve observed in the market, which appear to value common equity significantly more in times of distress.

Sixth, the test provides very strong incentives for firms to increase common equity without resorting to the government for same. That’s a good thing, because private capital is far preferable, and banks will have six months to get to that result. Indeed, a number of banks have already announced their intention to raise new common equity, and my fervent hope is that very little government capital will be required at the end of the six-month period.

One final note of caution: while we have some good news today, credit losses in banks are likely to increase in the coming months across all asset classes. Supervisors are very focused on this concern. Banks will need strong capital to weather these losses while continuing to make loans to creditworthy borrowers – which is exactly what the stress test is designed to ensure. The OCC and the other supervisors will continue ongoing rigorous supervision of banks' capital adequacy.